There is a present need in asset management to move towards “liability-led investing” at the individual and/or household level. Currently, there is an observable trend for governments and corporations to push the responsibility for pension and healthcare liability management and financing back to the individual because existing arrangements for their funding are either unaffordable or the financing risk is too high. Consequently, it has become increasingly important for individuals to accurately model their financial condition into the future in order to plan for multiple goals such as retirement, college education for children, etc.
Such modeling is a challenging task. Most individuals have multiple future goals, some flexibility in the timing and acceptable spend of those future goals (e.g., they can retire earlier or later; retire on a higher or lower retirement income) and dynamic goal priorities (e.g., will trade-off goals differently depending on the likely level of spend). Dependencies between these goals go forwards and backwards in time. For example, if an individual (or household) spends more on their children's education, he or she will have less to support retirement. On the other hand, if the individual retires later, he or she may be able to afford to spend more on their children's education today.
On top of this wide array of goals and related choices, individuals (and households) face uncertainty about their future income, future expenses, and even how long they are going to live. For example, there is uncertainty about an individual's future earned income, social security receipts, Medicare benefits and returns on their savings and investments. There is also uncertainty about an individual's future expenditures on healthcare, nursing care, residential care, etc. There is a risk the individual may die young. Under those circumstances, they want to be sure their family is provided for. There is also a risk the individual may live a long time. In that case, they want to be sure that they have enough assets to support them through a very long retirement, where healthcare costs may be high.
When considering assets, liabilities, goals, and the uncertainties of life, people care about every outcome. There are, however, too many variables for any individual, no matter how intelligent, to solve the problem in all of its complexities and find comprehensive answers. Most individuals solve the problem serially. For example, if they have enough money, they will send their children to a particular school without a thorough understanding of how that would affect their retirement age or spend, or how it would impact their family if they were to die unexpectedly.
There are existing tools for modeling an individual's financial situation, however, they do not fully address the problem. In general, existing tools focus on funding individual goals and ignore the interactions and time dependencies between cashflows and their priorities. They ignore unforeseen events such as health events or the need for long-term care. These existing tools assume that the only risk decision to be made by the individual is how much risk to take in the investment portfolio. They therefore focus the individual on expected portfolio returns, or the degree of investment risk needed to meet that single goal. They do not help the individual assess the nature of the risks to their meeting their set of goals, nor help them understand the nature and consequences of the choices they have, of which investment risk is but one.